In Urban Mechanical Contracting Ltd. v. Zurich Insurance Company Ltd.,1 the Court of Appeal considered whether, as a matter of law, rescission is available on the basis of fraudulent misrepresentations and collusion – even when doing so would affect the rights of innocent third parties.

The court held that, as a matter of law, the rights of innocent third parties are not an absolute bar to rescission, particularly in cases of fraudulent misrepresentation and where it may be possible to provide restitution in other ways.

BACKGROUND

The case dealt with a public-private redevelopment project with Infrastructure Ontario to construct a new 17-story patient care tower at St. Michael's Hospital. The construction was to be financed and carried out by the private sector. The construction contract was awarded to a subsidiary of Bondfield Construction Company Ltd. through Infrastructure Ontario's procurement process. Bondfield was made the general contractor of the project. A syndicate of lenders financed the project by way of a $230M loan to Bondfield.

In January 2015, Zurich Insurance Company issued a $156M performance bond and a $142M payment bond. Beginning in 2017, Bondfield struggled to meet payment deadlines. Zurich acted on the bond and paid some of the subcontractors and suppliers to continue the construction of the project.

After a dispute over whether BMO could demand payment without exercising step-in rights under the construction contract, BMO obtained a court order appointing a receiver to call on the performance bond. In the midst of the dispute, one of Zurich's consultants uncovered numerous email communications between Bondfield and Hospital representatives disclosing allegedly fraudulent misrepresentations and collusion, which appeared to have enabled Bondfield to secure the contract for the Project.

THE SUPERIOR COURT APPLICATION

Zurich ceased paying subcontractors and suppliers and commenced an action seeking a declaration that both the performance and payment bonds be rescinded due to fraud in the procurement process. Zurich took the position that, had it known about the fraud, it would never have issued the bonds. BMO and the subcontractors brought two applications seeking a declaration that Zurich may not rescind the bonds because doing so would affect their rights as innocent third parties. The application judge ruled that rescission may be possible, but without a full factual record, could not determine whether the remedy was available to Zurich, and found that the issue should be determined on a full factual record at trial. This decision was appealed to the Court of Appeal.

THE COURT OF APPEAL DECISION

The Court of Appeal dismissed the appeal and upheld the application judge's decision. The court affirmed that prejudice to the rights of third parties may be, but is not always, a bar to rescission. This is particularly true in the case of fraudulent misrepresentation in cases where it is possible to provide restitution in other ways. Even when the parties cannot be restored to the state they were in before the contract was signed, courts may still grant and tailor a rescission remedy because rescission is an equitable remedy focused on practical justice, not rigid technicalities.

As the application judge made no error of law, the court found deference was owed to her conclusion that the issue of rescission should proceed to trial on a full factual record so that the trial court may consider all the circumstances and equities of the case. This determination accords with the principles of rescission as an equitable remedy and the high degree of flexibility courts exercise in rescinding contracts in cases of fraud. In the absence of a full factual record, the court could not determine whether rescission could be tailored to achieve practical justice for the appellants and respondents. The Court of Appeal dismissed the appeal and ruled that determination of the issue should be left to the trial judge to determine what, if any, equitable claims and remedies arise in the circumstances.

Footnote

1 2022 ONCA 589.

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